Do you have a private company in your group structure? Have you been enjoying paying tax at a flat rate of 30%, as opposed to the top marginal tax rate in your personal return? Well, then hopefully you’ve heard about accountants’ favourite way to bore and confuse you – Division 7A.
What is Division 7A?
Division 7A (Div. 7A) deals with payments, loans and even debt forgiveness made by private companies. The Div. 7A law was introduced on 4 December 1997. Prior to this date, shareholders (and their associates) could happily tap in to concessionally-taxed funds from their private company at will. This proved to be a very effective ‘strategy’ should you find yourself in a tax bracket above 30%. As with anything that seems too good to be true, it often is. This is especially the case when it comes to the ATO. Now, should the Div. 7A rules apply, such payments, loans or debt forgiveness may find themselves treated as a deemed assessable unfranked dividend.
Some common misconceptions
1. It is often thought that Div. 7A only applies to shareholders as individuals. ‘Associates’ is a very broad term used by the ATO. It captures benefits made to family members or related entities, such as a family trust, in the group structure. The net of Div. 7A was further cast in 2009 to include Unpaid Present Entitlements (UPE’s) made by a trust to a private company. Should the UPE remain unpaid, this may amount to providing a benefit to the trust and therefore be a loan for Div. 7A purposes. See TR 2010/3. 2. Should the Div. 7A rules apply and a deemed dividend is triggered, the dividend is not necessarily assessable to the shareholder(s) of the company. It is important to note that the dividend is taken to have been paid to the person or entity who received the benefit.
What can I do? If any of the above situations sound familiar and you believe you may have inadvertently triggered Div. 7A – don’t fret! There are ways to avoid a deemed dividend. The most common of which being:
Repayment of the debt You have until the earlier of lodgement day of that years’ company tax return, or due date of the return to repay any benefit back to the company. Although this may sound simple, if you are not aware of the issue it can often be too late. Assume, for example, you have a great financial year and decide to rip out the profits of the company before 30 June. It’s your money after all, right? It gets to around May the following year and it is time to lodge the return. Your accountant identifies the Div 7A issue and lets you know the company will be needing those funds back.
Utilising a complying loan agreement If the funds are no longer available, a complying loan agreement is your next best option. Again, this decision must be made by the lodgement day of the company tax return. The loan terms can be either 7 years (unsecured loan) or 25 years (where the loan is secured over real property). Interest is applied to the loan at a benchmark rate set by the ATO. Annual repayments (principal and interest) must then be repaid back to the company over the life of the loan.
Finally, come see us! As tax advisers we are more than happy to step you through the complexities of provisions such as Div. 7A. The benefits of working closely with our clients and utilising cloud-based software, mean we can identify such issues before it’s too late.